The accompanying unaudited condensed consolidated
financial statements of Telkonet, Inc. (the “Company”, “Telkonet”) have been prepared in accordance with
Rule S-X of the Securities and Exchange Commission (the “SEC”) and with the instructions to Form 10-Q. Accordingly,
they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial
statements.

In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair presentation have been included. However, the results
from operations for the three months ended March 31, 2018, are not necessarily indicative of the results that may be expected for
the year ending December 31, 2018. The unaudited condensed consolidated financial statements should be read in conjunction with
the consolidated December 31, 2017 financial statements and footnotes thereto included in the Company's Form 10-K filed with the
SEC. Refer to Note C – Revenue, for the adoption of a new revenue recognition standard in the first quarter of 2018.

Telkonet, formed in 1999 and incorporated under
the laws of the state of Utah, is the creator of the EcoSmart Platform of intelligent automation solutions designed to optimize
energy efficiency, comfort and analytics in support of the emerging Internet of Things (“IoT”).

In 2007, the Company acquired substantially
all of the assets of Smart Systems International (“SSI”), which was a provider of energy management products and solutions
to customers in the United States and Canada and the precursor to the Company’s EcoSmart platform. The EcoSmart platform
provides comprehensive savings, management reporting, analytics and virtual engineering of a customer’s portfolio and/or
property’s room-by-room energy consumption. Telkonet has deployed more than a half million intelligent devices worldwide
in properties within the hospitality, military, educational, healthcare and other commercial markets. The EcoSmart platform is
rapidly being recognized as a leading solution for reducing energy consumption, operational costs and carbon footprints, and eliminating
the need for new energy generation in these marketplaces – all while improving occupant comfort and convenience.

On March 28, 2017, the Company sold substantially
all of the assets of its wholly-owned subsidiary, EthoStream, LLC. Refer to Note M for further details.

The condensed consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries, Telkonet Communications, Inc. The prior year accounts of
EthoStream LLC have been classified as discontinued operations on the consolidated statement of operations and the consolidated
statement of cash flows. All significant intercompany balances and transactions have been eliminated in consolidation.

We have financed our operations since inception
primarily through private and public offerings of our equity securities, the issuance of various debt instruments and asset based
lending.

The Company
reported a net loss from continuing operations of $1,184,166 for the three months ended March 31, 2018, had cash used in operating
activities from continuing operations of $991,884, had an accumulated deficit of $121,338,822 and total current assets in excess
of current liabilities of $7,890,259 as of March 31, 2018.

The Company computes earnings per share under
Accounting Standards Codification (“ASC”) 260-10, “Earnings Per Share”. Basic net income (loss) per common
share is computed using the treasury stock method, which assumes that the proceeds to be received on exercise of outstanding stock
options and warrants are used to repurchase shares of the Company at the average market price of the common shares for the year.
Dilutive common stock equivalents consist of shares issuable upon the exercise of the Company's outstanding stock options and
warrants. For the three months ended March 31, 2018 and 2017, there were 3,557,399 and 6,132,725 shares of common stock underlying
options and warrants excluded due to these instruments being anti-dilutive, respectively.

The U.S. Tax Cuts and Jobs Act (“Tax Act”)
was enacted on December 22, 2017. The Tax Act makes broad complex changes to the U.S. tax code including, but not limited to, reducing
the U.S. federal corporate tax rate from 35% to 21%, requiring companies to pay a one-time transition tax on earnings of certain
foreign subsidiaries that were previously tax deferred, and creating new taxes on certain foreign sourced earnings and additional
limitations on the deductibility of interest.

The SEC issued Staff Accounting Bulletin No.
118 (SAB 118) in December, 2017, to provide guidance on accounting for the effects of the Tax Act. SAB 118 provides for a measurement
period of up to one year from the Tax Act enactment date for companies to complete their assessment of and accounting for those
effects of the Tax Act. Under SAB 118, a company must first reflect the income tax effects of the Tax Act for which the accounting
is complete in the period of the date of enactment. To the extent the accounting for other income tax effects is incomplete, but
a reasonable estimate can be determined, companies must record a provisional estimate to be included in their financial statements.
For any income tax effect for which a reasonable estimate cannot be determined, an entity must continue to apply ASC 740 based
on the provisions of the tax laws in effect immediately prior to the Tax Act being enacted until such time as a reasonable estimate
can be determined. The Company requires additional time to complete its analysis of the impacts of the Tax Act and therefore its
accounting for the Tax Act is provisional but is a reasonable estimate based on available information. The Company will complete
its analysis and finalize its accounting for this provisional estimate during the one year measurement period as prescribed by
SAB 118.

The preparation of financial statements in conformity
with United States of America (U.S.) generally accepted accounting principles (GAAP) requires management to make certain estimates,
judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates
are used when accounting for items and matters such as revenue recognition and allowances for uncollectible accounts receivable,
inventory obsolescence, depreciation and amortization, long-lived assets, taxes and related valuation allowance, income tax provisions,
stock-based compensation, and contingencies. The Company believes that the estimates, judgments and assumptions are reasonable,
based on information available at the time they are made. Actual results may differ from those estimates.

The Company accounts for income taxes in accordance
with ASC 740-10 “Income Taxes.” Under this method, deferred income taxes (when required) are provided based on the
difference between the financial reporting and income tax bases of assets and liabilities and net operating losses at the statutory
rates enacted for future periods. The Company has a policy of establishing a valuation allowance when it is more likely than not
that the Company will not realize the benefits of its deferred income tax assets in the future.

The Company adopted ASC 740-10-25, which prescribes
a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. ASC 740-10-25 also provides guidance on derecognition, classification, treatment of interest
and penalties, and disclosure of such positions.

Accounting Standards Codification Topic 606,
Revenue from Contracts with Customers (“ASC 606, the Standard”) supersedes nearly all legacy revenue recognition guidance.
ASC 606 outlines a comprehensive five-step revenue recognition model based on the principle that an entity should recognize revenue
based on when an it satisfies its performance obligations by transferring control of promised goods or services in an amount that
reflects the consideration to which the entity expects to be entitled in exchange for said goods or services.

Identify the customer contracts

The Company accounts for a customer contract
under ASC 606 when the contract is legally enforceable. A contract is legally enforceable when all of the following criteria are
met: (1) the contract has been approved by the Company and the customer and both parties are committed to perform their respective
obligations, (2) the Company can identify each party’s rights regarding goods or services transferred, (3) the Company can
identify payment terms for goods or services transferred, (4) the contract has commercial substance, and (5) collectability of
all the consideration to which the Company is entitled in exchange for the goods or services transferred is probable.

A contract does not exist if each party to the
contract has the unilateral right to terminate a wholly unperformed contract without compensating the other party (or parties).
Nearly all of the Company’s contracts do not contain such mutual termination rights for convenience. All contracts are in
written form.

Identify the performance obligations

The Company will enter into product only contracts
that contain a single performance obligation related to the transfer of EcoSmart products to a customer.

The Company will also enter into certain customer
contracts that encompass product and installation services, referred to as “turnkey” solutions. These contracts ultimately
provide the customer with a solution that enhances the functionality of the customer’s existing equipment. For this reason,
the Company has determined that the product and installation services are not separately identifiable performance obligations,
but in essence represent one, combined performance obligation (“turnkey”).

The Company also offers post-installation support
services to customers. Support services are considered a separate performance obligation.

Determine the transaction price

The Company generally enters into contracts
containing fixed prices. It is not customary for the Company to include contract terms that would result in variable consideration.
In the rare situation that a contract does include this type of provision, it is not expected to result in a material adjustment
to the transaction price. The Company regularly extends pricing discounts; however, they are negotiated up front and adjust the
fixed transaction price set out in the contract.

Customer contracts will typically contain upfront
deposits that will be applied against future invoices, as well as customer retainage. The intent of any required deposit or retainage
is to ensure that the obligations of either party are honored and follow customary industry practices. In addition, the Company
will typically be paid in advance at the beginning of any support contracts, consistent with industry practices. None of these
payment provisions are intended to represent significant implicit financing. The Company’s standard payment terms are thirty
days from invoice date. Products are fully refundable when returned in their original packaging without damage or defacing less
a restocking fee not to exceed fifty (50%) percent of the product’s price. Historical returns have shown to be immaterial.
The Company offers a standard one-year assurance warranty. However customers can purchase an extended warranty. Under the new standard,
extended warranties are accounted for as a service warranty, requiring the revenue to be recognized over the extended service periods.
Contracts involving an extended warranty are immaterial and will continue to be combined with support revenue and recognized on
a straight-line basis over the support revenue term.

Allocate the transaction price to the performance obligations

Revenues from customer contracts are allocated
to the separate performance obligations based on their relative stand-alone selling price (“SSP”) at contract inception.
The SSP is the price at which the Company would sell a promised good or service separately. The best evidence of an SSP is the
observable price of a good or service when the entity sells that good or service separately in similar circumstances and to similar
customers. However, turnkey solutions are sold for a broad range of amounts resulting from, but not limited to, tiered discounting
for value added resellers (“VAR”) based upon committed volumes and other economic factors. Due to the high variability
of our pricing, the Company cannot establish a reliable SSP using observable data. Accordingly, the Company uses the residual approach
to allocate the transaction price to performance obligations related to its turnkey solutions.

All support service agreements, whether single
or multi-year terms, automatically renew for one-year terms at a suggested retail price (“SRP”). Support service renewals
are consistently priced and therefore would support the use of SRP as the best estimate of an SSP for such performance obligations.

Recognize Revenue

The Company recognizes revenues from product
only sales at a point in time, when control over the product has transferred to the customer. As the Company’s principal
terms of sale are FOB shipping point, the Company primarily transfers control and records revenue for product only sales upon
shipment.

A typical turnkey project involves the installation
and integration of 200-300 rooms in a customer-controlled facility and usually takes sixty days to complete. Since control over
goods and services transfers to a customer once a room is installed, the Company recognizes revenue for turnkey solutions over
time. The Company uses an outputs measure based on the number of rooms installed to recognize revenues from turnkey solutions.

Revenues from support services are recognized
over time, in even daily increments over the term of the contract.

Deferred revenue includes deferrals for the
monthly support service fees. Long-term deferred revenue represents support service fees that will be recognized as revenue after
March 31, 2019.

Transition

The Company adopted ASC 606 using a modified
retrospective approach to all contracts not completed as of January 1, 2018. Results for reporting periods beginning January 1,
2018 are presented under ASC 606, while prior period amounts were not adjusted and continue to be reported in accordance with the
Company’s historic accounting under Topic 605, Revenue Recognition. The Company recorded a net decrease to beginning retained
earnings of $0.43 million as of January 1, 2018 due to the cumulative impact of adopting ASC 606. The impact to beginning retained
earnings was primarily driven by the deferral of revenue for unfulfilled performance obligations related to the Company’s
turnkey solutions.

The Company records a liability for potential
warranty claims in cost of sales at the time of sale. The amount of the liability is based on the trend in the historical ratio
of claims to sales, the historical length of time between the sale and resulting warranty claim, new product introductions and
other factors. The products sold are generally covered by a warranty for a period of one year. In the event the Company determines
that its current or future product repair and replacement costs exceed its estimates, an adjustment to these reserves would be
charged to earnings in the period such determination is made. For the three months ended March 31, 2018 and the year ended December
31, 2017, the Company experienced returns of approximately 1% to 2% of materials included in the cost of sales. As of March 31,
2018 and December 31, 2017, the Company recorded warranty liabilities in the amount of $55,316 and $59,892, respectively, using
this experience factor range.

Product warranties for the three months ended
March 31, 2018 and the year ended December 31, 2017 are as follows:

The entire disclosure for the business description and basis of presentation concepts. Business description describes the nature and type of organization including but not limited to organizational structure as may be applicable to holding companies, parent and subsidiary relationships, business divisions, business units, business segments, affiliates and information about significant ownership of the reporting entity. Basis of presentation describes the underlying basis used to prepare the financial statements (for example, US Generally Accepted Accounting Principles, Other Comprehensive Basis of Accounting, IFRS).

Disclosure of accounting policy for computing basic and diluted earnings or loss per share for each class of common stock and participating security. Addresses all significant policy factors, including any antidilutive items that have been excluded from the computation and takes into account stock dividends, splits and reverse splits that occur after the balance sheet date of the latest reporting period but before the issuance of the financial statements.

Disclosure of accounting policy for income taxes, which may include its accounting policies for recognizing and measuring deferred tax assets and liabilities and related valuation allowances, recognizing investment tax credits, operating loss carryforwards, tax credit carryforwards, and other carryforwards, methodologies for determining its effective income tax rate and the characterization of interest and penalties in the financial statements.

Disclosure of accounting policy for revenue recognition. If the entity has different policies for different types of revenue transactions, the policy for each material type of transaction is generally disclosed. If a sales transaction has multiple element arrangements (for example, delivery of multiple products, services or the rights to use assets) the disclosure may indicate the accounting policy for each unit of accounting as well as how units of accounting are determined and valued. The disclosure may encompass important judgment as to appropriateness of principles related to recognition of revenue. The disclosure also may indicate the entity's treatment of any unearned or deferred revenue that arises from the transaction.

The entire disclosure when substantial doubt is raised about the ability to continue as a going concern. Includes, but is not limited to, principal conditions or events that raised substantial doubt about the ability to continue as a going concern, management's evaluation of the significance of those conditions or events in relation to the ability to meet its obligations, and management's plans that alleviated or are intended to mitigate the conditions or events that raise substantial doubt about the ability to continue as a going concern.